Producer Contract Fundamentals

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The article below is a wonderful overview of producer contract basics and the differentiation between ownership, vesting, and deferred compensation.  

Written by:
By Bill Schoeffler, CIC and Catherine Oak, CIC, AAI
One of the amazing things that occurs in some agencies, even successful ones, is that often the producers have not signed contracts. There are three main reasons for the lack of contracts.

The most common is that the agency owner and the producer has a verbal agreement. Usually the owner is reluctant to put the agreement in writing for fear that the producer will not sign one any way and might leave if forced to sign.

The second reason is that the owner just did not take the time to draft an agreement or did not know were to start. The third most common reason is that the owner feels contracts are a waste of time and money. They believe that if a producer wants to leave and violate the contract they will.

The last reason does have a bit of truth to it. However, if a producer does violate a contract, at least the owner does have a means of recourse. This is especially true if the agreement is fair.

Those who feel a verbal agreement will suffice or fail to take the time to write an agreement are playing with fire, and will get burnt. Without a contract, any dispute must rely on verbal agreements, implied agreements and common practices. The results of such disputes are up in the air. At least with a contract both sides have a common starting point in which to resolve their disagreements.

One of the biggest reasons to have a contract with a producer is to clearly state who owns the business. Producers often feel that since they generated the business they own it. Whereas many owners feel that since they own the agency, they also own all of the business. The conflict arises when these two opposites do business together.

The time and money it takes to put a contract together seems trivial when a producer with a $250,000 commission book of business walks away. Sometimes the ownership issues pop up only when the agency owner is retiring, only to find out their agency is worth a lot less because they do not own the producer’s book of business.

THE STARTING POINT
There are many boilerplate or do it yourself contracts out there. Some of these are quite well written. They can be used as the starting point for negotiations between the parties. Or, you may chose to start with a plain language Letter of Intent that outlines all the terms agreed to by all parties.

The next step is important. HAVE A COMPETANT LEGAL ADVISOR REVIEW AND APPROVE ALL YOUR CONTRACTS. Boilerplates are fine to an extent, but laws change and vary from state to state, so never do all the contract work without an attorney who has experience with producer contracts. If you start with a Letter of Intent, the attorney can use it as the raw material for a contract.

So what are the key elements that make up a good contract? The first thing to consider is that each agency and producer is unique and that a contract can and should vary based on the circumstances. There are, however, some basic components that each contract should contain. The most common elements are:

Parties to the Agreement and Recital – State the name of all parties (individuals and entities) that are entering into the agreement. The recital provides a brief overview of the background and why the agreement is being written.

Term of Employment or Contract – State how long this agreement will run. It can be open ended, if so desired.

Responsibilities of the Producer – Describe the duties expected from the producer. Always add a line that duties include any reasonable task requested or assigned to him/her by the employer. This is a good “catch-all” phrase.

Obligations of the Employee – Explain what the employer will provide the producer to enable them to perform their work.

Compensation and Benefits – Outline the compensation plan and any benefits provided.

Exclusive Nature of Employment – State that the employee is to devote their full time and efforts exclusively for the benefits of the business. This section should not be included in a contract with an independent contractor.

Termination of Agreement – Describe what the rules will be for termination of employment.

Death and Disability Issues – Many contracts omit this valuable section. Make sure it is understood how the death or disability of the producer will impact the agreement.

Non-Disclosure and Non Piracy – Clearly state the importance of non-disclosure and non-piracy of the agency materials. If included in the contract, it is most likely to hold up in court.

Ownership of Accounts, Expiration Lists and Renewals – Describe how the ownership of the accounts will be handled.

Injunctive Relief and Damages – Spell out the ramification of any violations of the agreement.
Assignment of Agreement – Allow for the assignment of the contract to a third party, such as a buyer of the agency.

Invalidity of Specific Sections – This section allows for the rest of the agreement to remain intact, if a specific section becomes invalid for some reason.

In addition to these sections, there will be additional sections related to common legal practices in a contractual agreement, such as Applicable Law, Binding Effects, Amendments, Waivers, Arbitration and Complete Agreement.

IS IT NEGOTIABLE?
Some of these sections are negotiable, such as Compensation and Obligation of the Employee. It is important, however, that the agency owner not negotiate on other sections such as Non Disclosure, Assignment of Agreement and Termination of Agreement.

The sections that tend to be the most important to the owner and the producer revolve around compensation and ownership issues. The approach towards these two issues needs to be customized based on the needs, expectations and position of the parties.

Insights on how to handle producer compensation was addressed in a prior article (VVVVV). The bottom line on compensation is that it needs to be rewarding and motivating for the producer, affordable to the owner and fair to both parties.

OWNERSHIP OF ACCOUNTS
There is a wide range in how account ownership is handled, or mishandled, by many contracts today. Some agreements have the producer owning it all, some have the agency own it all and some fall in between.

The problem is that sometimes account ownership has been used as the vehicle for a vesting agreement or deferred compensation plan. It is important to keep the concept of account ownership separate from the concept of a vesting agreement or deferred compensation plan.

The ownership of the accounts, renewals and expiration lists should always remain with the agency. The contract should clearly state this fact. This will prevent any misunderstanding about who owns the accounts. The vested interest, if allowed, should be strictly a financial benefit to the producer, not an ownership interest in the accounts.

If the two parties agree to some sort of vesting or deferred compensation, that should be spelled out separately from account ownership. In a vesting agreement, the producer has a vested interest in some portion of the renewal commissions generated by the accounts, while the ownership still remains wit the agency. This agreement can be part of the employment contract or it can be its own agreement.

A deferred compensation plan can be effectively the same as a vesting agreement. It is probably less confusing to use the deferred compensation terminology rather than the vesting terminology, since the latter may be confused with an ownership of the accounts.

Keep in mind that a deferred compensation plan can be unrelated to the producer’s book of business. For example, the employee may earn $10,000 in deferred compensation per year of employment.

The terms of the deferred compensation or the vesting agreement needs to be clearly stated. Why bother saying that a producer is 50% vested in their accounts without describing how the value will be determined? Failure to state how the value is determined will only cause more problems.

A “rule of thumb” multiple for value is the most common approach. The main problem with a rule of thumb, such as one times commission, is that it may not reflect the fair value of that particular book of business. It makes sense to include the option for a professional appraisal if a dispute arises.

The contract can also allow the producer to buy the accounts from the agency. This makes the agreement bilateral and may help the agreement to be construed as fair in the courts. The agency, however, should always reserve the right to sell (or not).

SUMMARY
Good producers are hard to find. For an agency owner to spend a lot of time and money finding and developing a good producer, it only makes sense to have a clear understanding of what their agreement is. When both parties know what the terms are and agree to them in writing, it tends to keep both sides honest and more likely to follow the terms.

The legal world is not perfect and valid contracts sometimes don’t hold up for one reason or another. An agency’s clients are better off with the proper insurance then no insurance at all. In a similar fashion, an agency and producer are better off with a written contract then no contract. A well-written producer contract is a form of assurance to a good relationship between the agency and the employee.

Bill Schoeffler and Catherine Oak are partners in the international consulting firm, Oak & Associates, based in Northern California. The firm specializes in financial and management consulting for national and international insurance agencies, including valuations, mergers acquisitions, clusters, sales and marketing planning as well as perpetuation planning. They can be reached at (707) 936-6565 or by e-mail at catoak@sonic.net.

Written by:
By Bill Schoeffler, CIC and Catherine Oak, CIC, AAI